Defalcation While Acting in a Fiduciary Capacity: What Does it Mean?
| Publication year | 1995 |
| Pages | 1773 |
1995, August, Pg. 1773. Defalcation While Acting in a Fiduciary Capacity: What Does it Mean?
Many debtors seeking a discharge of debt under the Bankruptcy Code(fn1) must overcome a challenge from an aggrieved creditor alleging that wrongful conduct of a debtor precludes the discharge of the debt to that creditor. Code § 523(a)(4) excepts from discharge a debt arising from a debtor's "fraud or defalcation while acting in a fiduciary capacity, embezzlement, or larceny...." A creditor seeking a determination of nondis-chargeability under this section must prove (1) that the debtor committed fraud or defalcation while acting in a fiduciary capacity; or (2) that the debtor committed embezzlement or larceny. Creditors often prefer to assert the defalcation in a fiduciary capacity exception because the term "defalcation" has consistently been interpreted to encompass a wider spectrum of conduct than that which is included in the terms "fraud," "embezzlement" and "larceny," and because many courts have held that the debtor's bad faith or misconduct is not a necessary element of this exception.(fn2)
The terms "fiduciary capacity" and "defalcation" are not defined in the Code. Consequently, they have been the subject of more than 100 years of judicial interpretation.(fn3) Despite, or perhaps as a result of, this extensive judicial history, the meaning of fiduciary capacity and defalcation is still far from clear. This article explores the meaning of these terms as interpreted and construed by federal courts in the Tenth Circuit, with an emphasis on decisions of the U.S. Bankruptcy Court for the District of Colorado.
The meaning of fiduciary capacity under Code § 523(a)(4) is a matter of federal law(fn4) and is narrower than the traditional, common-law meaning of the term "fiduciary."(fn5) The traditional use of the term, which typically describes a relationship involving confidence, trust and good faith, is not applicable in discharge-ability proceedings under § 523(a)(4).(fn6) In addition, the phrase "fiduciary capacity" does not encompass ordinary commercial relationships, such as principal-agent and debtor-creditor,(fn7) even though those relationships may entail fiduciary obligations and duties under common law. Rather, the phrase "fiduciary capacity" as used in § 523(a)(4) has been interpreted to require an express or technical trust(fn8) that must exist prior to the creation of the debt in controversy.(fn9) Accordingly, fiduciary capacity will not be found in cases involving constructive trusts or trusts imposed ex maleficio; trusts imposed by law because of wrongdoing or after wrongdoing are not sufficient to establish fiduciary capacity.
An express trust requires sufficient words to create a trust, a clearly defined trust res and the intent to create a trust relationship.(fn10) An express trust usually requires a written document or trust instrument that expressly states that an individual is to hold specific property as trustee for another.(fn11) Cases involving express trusts are fairly straightforward, and fiduciary capacity will almost always be found to exist between the trustee and the beneficiary of an express trust.(fn12)
A technical trust differs from an express trust in that it is a trust imposed by law. In the District of Colorado and elsewhere within the Tenth Circuit, federal courts have held that technical trusts may arise either by statute or common law.(fn13) A minority of other jurisdictions have limited the application of § 523(a)(4) to situations involving express trusts and have indicated an unwillingness to extend the concept of fiduciary capacity to statutory or common-law technical trusts.(fn14)
Judicial opinions from the Tenth Circuit that have discussed statutory technical trusts have generally required at least an express legislative design to create a trust relationship before finding a technical trust to exist.(fn15) One of the first cases in the Tenth Circuit to find a technical trust based on a statute was In re Romero.(fn16) In Romero, the Tenth Circuit affirmed the District Court's imposition of a technical trust based on a New Mexico licensing statute for contractors
Since Romero, federal courts within the District of Colorado have had the opportunity to refine this analysis...
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